Ince&Co International Law Firm

Damages against a shipbuilder: the Gearbulk decision

Saturday 02 May, 2009

Gearbulk Holdings Limited v Stocznia Gdynia SA [2009] 1 Lloyd's Rep Plus 26

The English Court of Appeal has recently issued an important judgment that clarifies the exposure of a builder for damages if a shipbuilding contract is terminated by a buyer in circumstances where the builder is in breach. As we reported in the July 2008 edition of our E-brief, the Commercial Court had extended existing authorities and held that by recovering monies under the refund guarantee the buyer had affirmed the contract and was therefore unable to claim common law damages from the builder. The Court of Appeal has now reversed this decision.

Facts

The builder failed to construct and deliver three vessels. The buyer terminated the contracts, then recovered under the refund guarantees the pre-delivery instalments of the contract price plus interest. He also commenced arbitration against the builder, claiming damages for repudiatory breach.

The Common Law Position

Under English law, when there is a repudiatory breach, that is, a breach that is sufficiently serious to go to the root of the contract, the innocent party normally has a choice: he can either accept the breach as bringing the contract to an end, or he can hold the other party to the contract. If he does something which is inconsistent with the contract terminating, he may be said to have “affirmed” the contract and so he may lose the right to treat it as ended.

In this case, the builder relied upon three arguments in defence to the buyer's claim for damages under common law:

1) the terms of the contract excluded the buyers right to terminate at common law and instead put in place a contractual mechanism for termination;

2) the contract excluded claims for common law damages for loss of bargain in the event of termination; and

3) by exercising an express right to terminate the contracts and calling upon the refund guarantees, the buyer had affirmed the contract and was precluded from claiming damages.

Contractual Exclusion of Common Law Rights

On issues 1) and 2), the buyer's arguments were rejected by the arbitrator, the first instance Judge and the Court of Appeal.

The Court of Appeal found that the primary purpose of the relevant contractual provisions was to provide an agreed measure of compensation for breaches of contract by way of delay in delivery and deficiencies in capacity and performance which, although important, did not go to the root of the contract. In relation to breach of those obligations, the parties had agreed the payment of liquidated damages. To this extent, they had displaced the general law, at least as regards the measure of damages recoverable for the breach in question. The parties had also agreed that there came a point in time at which the delay or deficiency was so serious as to entitle the buyer to terminate the contract, at which point the breach was to be treated as going to the root of the contract. The Court of Appeal held that, in those circumstances, the right to terminate could not sensibly be understood as embodying anything other than the parties’ agreement that the buyer had a right to treat the contract as repudiated with the usual consequences.

The Court of Appeal also agreed with the arbitrator and first instance Judge that the provisions of the contract were not effective to exclude the buyer's right to recover damages for loss of bargain. On this issue, it was stated that the court was unlikely to be satisfied that a valuable right arising by operation of law had been abandoned unless the terms of the contract made it sufficiently clear that that was intended. The more valuable the right, the clearer the language will need to be.

Affirmation and Repudiation

On the third issue, the first instance Judge had decided that the buyer had affirmed the contracts by terminating the contract in reliance on the contractual provisions which gave them a right to claim under the refund guarantees and claiming on the refund guarantees. Consequently, the buyer’s remedy was limited to the recovery of the instalments of the price from the refund guarantor plus interest accrued on those instalments.

The Court of Appeal did not agree with the Judge. They said that the buyer’s exercise of the right to terminate under the express terms of the contract “was intended to and did operate to discharge the contract with the same consequences as if it had been discharged by repudiation in accordance with the general law”.

As for the refund guarantee:

“[T]he right to recover the instalments of the price, together with the right to obtain payment under the bank guarantee, arose only on and by reason of the termination of the contract. I think it is clear, therefore, that the parties intended it to survive the termination of the contract, just as, for example, they intended the arbitration clause to survive. Reliance on that obligation could not, therefore, amount to an election to keep the contract in being.”

Shipbuilding contracts very often contain clauses which at first sight might be thought to limit the buyer to claiming a refund and which exclude the buyer’s right to claim damages when he exercises a contractual right to terminate. However, very often the clauses fail to do so. In principle, the right to damages can be excluded or limited by drafting a suitable term in the contract. But for this purpose, the builder would have to get the buyer to agree to very clear words of exclusion.

Ince & Co acted for the successful buyers

michael.stockwood@incelaw.com
rania.tadros@incelaw.com

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